Carmax Auto v. SCDR ( 2014 )

THE STATE OF SOUTH CAROLINA
In The Supreme Court
Carmax Auto Superstores West Coast, Inc.,
Respondent/Petitioner,
v.
South Carolina Department of Revenue,
Petitioner/Respondent.
Appellate Case No. 2012-212203
ON WRIT OF CERTIORARI TO THE COURT OF APPEALS
Appeal From The Administrative Law Court
Carolyn C. Matthews, Administrative Law Judge
Opinion No. 27474
Heard March 19, 2014 – Filed December 23, 2014
AFFIRMED AS MODIFIED
Adam N. Marinelli, Milton G. Kimpson, and Roxanna M.
Tinsley, all of South Carolina Department of Revenue, of
Columbia, for Petitioner/Respondent.
John C. von Lehe, Jr. and Bryson M. Geer, both of
Nelson Mullins Riley & Scarborough, LLP, of
Charleston, for Respondent/Petitioner.
Robert L. Widener and Erik P. Doerring, both of McNair
Law Firm, PA, of Columbia, for Amicus Curiae, South
Carolina State Chamber of Commerce.
Burnet R. Maybank, III, of Nexsen Pruet, LLC, of
Columbia and Alexandra E. Sampson, of Reed Smith,
LLP, of Washington, DC, for Amicus Curiae, Council on
State Taxation.
CHIEF JUSTICE TOAL: Both CarMax Auto Superstores West Coast, Inc.,
(CarMax West) and the South Carolina Department of Revenue (the Department)
appeal the court of appeals' decision, reversing and remanding the decision of the
Administrative Law Court (ALC) upholding the Department's use of an alternative
apportionment formula to calculate CarMax West's income tax for tax years 2002-
2007. We affirm as modified in an opinion which resolves all matters with finality
and decline to remand at both parties' request.
FACTS/PROCEDURAL BACKGROUND
CarMax, Inc., (CarMax) was formed in 1993 as a subsidiary of Circuit City
Stores, Inc., and is the nation's largest retailer of used automobiles. In 2002,
CarMax became a separate, publicly-traded holding company of CarMax Auto
Superstores, Inc., (CarMax East) and CarMax West, two wholly owned
subsidiaries, which primarily performed retail automobile sales. CarMax East
owned and operated the used car superstores on the East Coast and in the Midwest,
including South Carolina, and managed all of the financial operations and
corporate overhead of CarMax. CarMax West owned and operated the used car
superstores on the West Coast and owned all of the intellectual property. From
2002-2004, CarMax East paid royalties to CarMax West for the use of this
intellectual property in accordance with a licensing agreement.
In 2004, CarMax reorganized its corporate structure, and created CarMax
Business Services, LLC (CBS), a multi-member limited liability company with
two members: CarMax East and CarMax West. CarMax East contributed the
financing operations and corporate overhead management to the partnership, and
CarMax West contributed the intellectual property. Ownership percentages of
CBS were based on the value of the assets contributed, and the members' income
derives from their respective percentages of ownership.1
1
CarMax West owns 93.5% of CBS, and CarMax East owns 6.5% of CBS.
After the restructuring, CarMax East and CarMax West became vehicle
retailers only, and CBS began to provide all of the corporate overhead services,
house financing operations through its financing arm (CAF), and manage the
intellectual property for its members. Both CarMax East and CarMax West pay
CBS a management fee for these services.2
CarMax West claims that it has no financial connection to South Carolina
outside of royalty payments from CarMax East. From 2002-2004, CarMax East
made direct payments to CarMax West for use of the intellectual property; and
since 2004, CarMax East has made management fee payments to CBS on a per-
vehicle-sold basis, and CAF has generated further financing revenue in South
Carolina. Because of its status as an LLC, CBS is taxed as a partnership; therefore,
both sources of revenue "flow through" CBS to its members, and thus indirectly, to
CarMax West.3
At issue is how an allocated portion of this income should be taxed in South
Carolina. CarMax West initially filed timely corporate income tax returns for tax
years 2002-2007.4 In 2008, the Department audited CarMax West, and issued a
proposed assessment, adjusting CarMax West's apportionment formula and
imposing penalties. CarMax West filed a protest, and in early 2009, the
Department issued a Determination upholding the Department's assessment.
Six months later, CarMax West filed the amended tax returns in question,
2
The management fee is assessed on a per-vehicle-sold basis. CBS further
generates revenue from providing financing to CarMax East's and CarMax West's
customers through CAF.
3
By virtue of its status as a "pass-through" entity for taxation purposes, CBS pays
no taxes in South Carolina.
4
In its initial filing, CarMax West utilized a "three-factor" or "three-factor double
weighted sales" formula, which calculates a taxpayer's taxable income in South
Carolina by computing a ratio of the taxpayer's total property, payroll, and sales.
See S.C. Code Ann. § 12-6-2250 (Supp. 2009), repealed by Act No. 110, 2007 S.C.
Acts 557, 595, and Act No. 116, 2007 S.C. Acts 688, 741 (repealing with respect
to tax years after 2010).
using the statutory apportionment method found in section 12-6-2290 of the South
Carolina Code. See S.C. Code Ann. § 12-6-2290 (2000 & Supp. 2009). This
method, commonly referred to as the "gross receipts method," calculates a
multistate taxpayer's taxes due by creating an apportionment ratio that divides the
taxpayer's receipts from financing and intangibles in South Carolina by the
taxpayer's receipts from financing, intangibles, and retail sales everywhere else the
taxpayer does business.5 CarMax West then multiplied its net income by the
apportionment ratio, and multiplied that number by South Carolina's income tax
rate to arrive at its South Carolina income tax.
The Department rejected CarMax West's use of the gross receipts method,
claiming it did not fairly represent the extent of CarMax West's business dealings
in South Carolina. Rather, the Department proposed an alternate apportionment
method pursuant to section 12-6-2320(A)(4) of the South Carolina Code. See S.C
Code Ann. §12-6-2320 (2000 & Supp. 2009).
The Department's proposed alternative formula employed an apportionment
ratio of CarMax West's South Carolina income from intangibles and financing
divided by CarMax West's intangibles and financing income from everywhere else
that it does business. According to the Department, this alternative formula
focused on CarMax West's actual business activity in South Carolina. The
Department sought to prevent CarMax West from diluting its income by inflating
the denominator of its apportionment ratio with sales from its Western retail
operations. Furthermore, the Department sought to include the income from the
sale of securitized consumer lending contracts in CarMax West's South Carolina
income. The Department still sought penalties.
After the Department issued a Final Agency Determination upholding the
Department's use of the alternate formula, CarMax West filed a contested case in
the ALC. The ALC affirmed the Department's use of an alternative apportionment
formula, but dismissed the penalties assessed against CarMax West. The ALC
found that (1) the Department demonstrated that the gross receipts formula failed
to fairly represent CarMax West's business in South Carolina; (2) the Department's
5
Prior to reorganization, CarMax West classified gross receipts from South
Carolina as the royalties, and after the reorganization, CarMax West attributed the
royalty portion of CBS as South Carolina receipts, but CarMax West did not
include the financing revenue within the numerator of the apportionment factor.
alternate apportionment formula was reasonable with respect to the extent of
CarMax West's business activity in South Carolina; (3) the financing receipts were
appropriately sourced to South Carolina; and (4) the alternative apportionment
formula did not violate the Commerce Clause.
CarMax West appealed the ALC's decision to the court of appeals. See
CarMax Auto Superstores W. Coast, Inc. v. S.C. Dep't of Revenue, 397 S.C. 604,
725 S.E.2d 711 (Ct. App. 2012). On appeal, CarMax West argued the ALC erred
in: (1) applying the wrong burden and standard of proof; (2) failing to consider that
CarMax West operates a unitary business and permitting the Department to use
separate accounting procedures when calculating tax liability of a unitary
business; (3) finding that CarMax West's South Carolina business activities were
not accurately calculated using the gross receipts method; (4) using the wrong test
in deciding that CarMax West's financing receipts should be sourced to South
Carolina; and (6) finding that the Department did not violate CarMax West's
constitutional rights by applying a separate accounting to a unitary business and by
sourcing financing receipts to South Carolina. Id. at 606, 725 S.E.2d at 712. The
court of appeals reversed and remanded the case to the ALC for application of the
proper burden of proof, without considering the remaining issues. Id. at 611, 725
S.E.2d at 714.
Both parties filed petitions for a writ of certiorari. This Court granted
review and accepted amici curiae briefs from the Council on State Taxation and the
South Carolina State Chamber of Commerce.
STANDARD OF REVIEW
The Administrative Procedures Act6 (the APA) "governs appellate review of
a final decision from an administrative agency." Hill v. Eagle Motor Lines, 373
S.C. 422, 427, 645 S.E.2d 424, 428 (2007) (citation omitted). In appeals taken
pursuant to the APA,
[t]he court may affirm the decision of the agency or remand the case
for further proceedings. The court may reverse or modify the decision
if substantial rights of the appellant have been prejudiced because the
administrative findings, inferences, conclusions, or decisions are:
6
S.C. Code Ann. §§1-23-310 to -400 (Supp. 2013).
(a) in violation of constitutional or statutory provisions;
(b) in excess of the statutory authority of the agency;
(c) made upon unlawful procedure;
(d) affected by other error of law;
(e) clearly erroneous in view of the reliable, probative, and
substantial evidence on the whole record; or
(f) arbitrary or capricious or characterized by abuse of
discretion or clearly unwarranted exercise of discretion.
S.C. Code Ann. § 1-23-380(5)(a)–(f) (Supp. 2013). However, the Court "may not
substitute its judgment for the judgment of the agency as to the weight of the
evidence on questions of fact." S.C. Code Ann. § 1-23-380(5); MRI at Belfair,
LLC v. S.C. Dep't of Health & Envtl. Control, 379 S.C. 1, 6, 664 S.E.2d 471, 474
(2008).
ANALYSIS
In South Carolina, corporate income tax "is imposed annually at the rate of
five percent on the South Carolina taxable income of every corporation . . .
transacting, conducting, or doing business within this State or having income
within this State, regardless of whether these activities are carried on in intrastate,
interstate, or foreign commerce." S.C. Code Ann. § 12-6-530 (2014). "A
corporation's taxable income in South Carolina is computed using the Internal
Revenue Code with modifications as provided by South Carolina law, and this
amount is 'subject to allocation and apportionment as provided in Article 17 of this
chapter.'" Media Gen. Commc'ns, Inc. v. S.C. Dep't of Revenue, 388 S.C. 138, 145,
694 S.E.2d 525, 528 (2010) (quoting S.C. Code Ann § 12-6-580 (2000)). When "a
taxpayer is transacting or conducting business partly within and partly without this
State, the South Carolina income tax is imposed upon a base which reasonably
represents the proportion of the trade or business carried on within this State."
S.C. Code Ann. § 12-6-2210(B) (2014).
"Article 17, entitled 'Allocation and Apportionment,' provides certain
income that is not related to business activity in South Carolina must be directly
allocated to a taxpayer and is not subject to apportionment." Media Gen., 388 S.C.
at 145, 694 S.E.2d at 528 (citing S.C. Code Ann. §§12-6-2220, -2230 (2000 &
Supp. 2009)). Any income "remaining after allocation is apportioned in
accordance with the general apportionment statute, section 12-6-2250, or one of
the special apportionment formulas" provided in Sections 12-6-2290 through 12-6-
2310. Id. at 145 (citing S.C. Code Ann. § 12-6-2240 (Supp. 2009)).
In this case, CarMax West utilized the statutory formula found in section 12-
6-2290 of the South Carolina Code, which requires a taxpayer to "apportion its . . .
net income using a fraction in which the numerator is gross receipts from within
this State during the taxable year and the denominator is total gross receipts from
everywhere during the taxable year." See S.C. Code Ann. 12-6-2290. However,
the Department sought to use an alternative method of apportionment pursuant to
section 12-6-2320(A) of the South Carolina Code, which provides:
If the allocation and apportionment provisions of this chapter do not
fairly represent the extent of the taxpayer's business activity in this
State, the taxpayer may petition for, or the department may require, in
respect to all or any part of the taxpayer's business activity, if
reasonable:
(1) separate accounting;
(2) the exclusion of one or more of the factors;
(3) the inclusion of one or more additional factors which will
fairly represent the taxpayer's business activity in the State; or
(4) the employment of any other method to effectuate an
equitable allocation and apportionment of the taxpayer's
income.
Burden of Proof
On appeal, the Department takes issue with the burden of proof adopted by
the court of appeals. Specifically, the Department contends the court of appeals
erred in applying Media General.7
7
CarMax West does not contest these findings; rather, CarMax West argues that
In its Order, the ALC properly applied a preponderance of the evidence
standard of proof, but also found that because the burden of proof "is generally
upon the party asserting the affirmative in an adjudicatory administrative
proceeding" and CarMax West requested the contested case hearing to challenge
the Department's proposed assessment, then CarMax West bore the burden of
proof.
The court of appeals reversed the ALC, finding it applied an incorrect
burden of proof under section 12-6-2320(A). CarMax, 397 S.C. at 611, 725 S.E.2d
at 714. The court of appeals reasoned:
There are two burdens of proof which must be met in this case. First,
we note both the Department and CarMax West agree the Department
bears the burden of proving the gross receipts formula does not fairly
represent CarMax West's business activity in South Carolina. Second,
the Department bears the burden of proving its alternative accounting
method is reasonable and more fairly represents CarMax West's
business activity in South Carolina.
Id. at 611, 725 S.E.2d at 714–15. Moreover, the court of appeals stated that
"based on Media General, the Department, as the proponent of the alternative
apportionment method, must establish that its alternative method is not only
appropriate, but more appropriate than any competing methods." Id. at 611, 725
S.E.2d at 714. Finding the ALC erred in requiring CarMax West satisfy the second
prong of the analysis, the court of appeals reversed the ALC and remanded for a
proper application of the burden. Id. at 612, 725 S.E.2d at 715.8
We find the statutory language of section 12-6-2320(A) clearly evinces a
two-part analysis, and we affirm the court of appeals in that respect. However, the
the court of appeals erred in refusing to consider the issues posed to it concerning
CarMax's status as a unitary business, the sourcing of the financing receipts to
South Carolina, and the constitutionality of the Department's application of South
Carolina's taxation scheme to it.
8
The court of appeals rejected CarMax West's contention below that the standard
of proof was clear and convincing evidence, and CarMax West has not appealed
that ruling. CarMax, 397 S.C. at 611–12, 725 S.E.2d at 714–15.
second prong of the analysis is met by a showing that the deviation from a
statutory apportionment formula is reasonable, and no further showing is required
at that stage. Thus, we find the court of appeals erred in requiring a showing that
the Department prove its alternate formula "more fairly represents CarMax West's
business activity in South Carolina," and further, we agree with the Department
that the court of appeals misapplied Media General in holding the Department
must prove that its alternate formula is "more reasonable than any competing
method."9
Accordingly, when a party seeks to deviate from a statutory formula under
section 12-6-2320(A), the proponent of the alternate formula bears the burden of
proving by a preponderance of the evidence that: (1) the statutory formula does not
fairly represent the taxpayer's business activity in South Carolina and (2) its
alternative accounting method is reasonable.
In so holding, we reject the Department's argument that the court of appeals
erred in failing to shift the burden to prove reasonableness to CarMax West. The
Department suggests that because it was the proponent of the statutory formula to
which the taxpayer raised an alternative formula in Media General, it was required
to supply another more appropriate formula in the face of the taxpayer's proposed
alternative. Consequently, in this case, where the roles are reversed, the
Department argues CarMax West must now prove its formula is more appropriate
9
In Media General, it was undisputed that the gross receipts formula did not fairly
represent the income of the multi-state taxpayer, and the alternative formula
proposed by the taxpayer did in fact fairly measure the taxpayer's business activity
in South Carolina. Media Gen., 338 S.C. at 146, 694 S.E.2d at 529. In upholding
the application of the alternative formula suggested by the taxpayer, we stated:
Although the Department has the discretion to select an alternative
method, the ALC has ordered in this case that the method be applied
and we affirm this determination as the Department has not
established that another method would be more appropriate.
Id. at 152, 152, 694 S.E.2d at 532. In contrast to the situation that arose in Media
General—where both parties agreed that the statutory formula did not fairly
represent the taxpayer's business in South Carolina—here, there was not the
potential for competing alternatives. Therefore, the proponent's showing that the
alternative formula is reasonable necessarily ends the inquiry.
than the Department's proposed alternative.
This argument is unavailing because it ignores the clear distinction between
this case and Media General. There, both the Department and the taxpayer agreed
that the statutory formula did not fairly represent the taxpayer's business in South
Carolina. The taxpayer supplied an alternative formula, but the Department fell
back on the statutory formula. Thus, in the context of that case, affirmation was
appropriate on the basis that the Department failed to select an alternative method,
but also failed to establish that another method would be more appropriate. Here,
however—where the Department alone is arguing that the statutory formula does
not fairly represent the taxpayer's business in South Carolina—the Department
bears the burden to prove (1) that the statutory formula does not fairly represent
CarMax West's business activity in South Carolina and (2) that the proposed
alternative formula is reasonable. Cf. St. Johnsbury Trucking Co. v. State, 385
A.2d 215, 217 (N.H. 1978) (holding "an alternative formula is the exception, and
the party who wants to use an alternative formula accordingly has the burden of
showing that the alternative is appropriate"); Donald M. Drake Co. v. Dep't of
Revenue, 500 P.2d 1041, 1044 (Or. 1972) (holding "the use of any method other
than apportionment should be exceptional" and the party seeking to use an
alternative method bears the burden of proof).
Therefore, we affirm the court of appeals finding that the ALC erred in
placing the burden of proof on CarMax West.
Application of the Burden
The Department contends that because it has proved that the statutory
formula did not fairly represent a taxpayer's business activity within the state, the
only issue on appeal is what burden of proof to apply to the question of whether
the Department's formula was reasonable. This formulation of the issue assumes
that the Department made a sufficient showing regarding the first prong of the
analysis. We find that it did not as a matter of law.10
While there is substantial evidence in the record to support the ALC's
finding that the Department's alternative accounting method was reasonable, the
10
At oral arguments, upon questioning by Justice Pleicones, both parties agreed
that this case should be resolved on this Record as a matter of judicial economy,
and that remand was unnecessary.
Department failed to prove the threshold issue that the statutory formula does not
fairly represent CarMax West's business activity within South Carolina.
As noted by the South Carolina State Chamber of Commerce in its amicus
brief, to satisfy its burden with respect to this first prong, the Department merely
"describe[d] what it did rather than cite any evidence justifying what it did."
Rather, at trial, the Department relied on CarMax West to refute its use of an
alternate formula, and it was in this context that CarMax West raised its unitary
business, sourcing, and constitutional arguments.
In its order, the ALC relied on testimony from an auditor that the business
structure of CarMax West and CBS is often "linked with tax minimization
strategies." Furthermore, the ALC relied on evidence regarding the sourcing of
income, and the fact that CarMax West's apportionment ratio yielded a
significantly lower tax than that of CarMax East, to support its determination that
CarMax West's income was diluted. This was the extent of the evidence offered by
the Department to prove the contention that the statutory formula did not fairly
represent CarMax West's business activity in South Carolina, other than bald
assertions by its witnesses that it satisfied this threshold question.
Even if these findings accurately characterize CarMax West's motives, they
do not provide a sound evidentiary basis to support the conclusion that the
statutory formula did not fairly represent CarMax West's business in South
Carolina. See St. Johnsbury Trucking Co., 385 A.2d at 217 ("Merely because the
use of an alternative form of computation produces a higher business activity
attributable to New Hampshire, is not in and of itself a sufficient reason for
deviating from the legislatively mandated formula." (citations omitted)).
Therefore, we find that the Department failed to satisfy its burden of proof
as a matter of law.11
CONCLUSION
11
We need not reach the CarMax West's remaining issues on appeal, as they were
all raised as defenses to the Department's use of an alternative apportionment
method, and the proper allocation of the burden of proof resolves this appeal. See
Futch v. McAllister Towing of Georgetown, Inc., 335 S.C. 598, 613, 518 S.E.2d
591, 598 (1999).
For the foregoing reasons, the opinion of the court of appeals is
AFFIRMED AS MODIFIED.
BEATTY, HEARN, JJ., and Acting Justice James E. Moore concur.
PLEICONES, J., concurring in part and dissenting in part in a separate
opinion.
JUSTICE PLEICONES: I concur in part and dissent in part. I agree with
the majority that the Court of Appeals was correct in reading S.C. Code Ann.
§ 12-6-2320(A) (2014) to place a two-part burden on the party seeking to
deviate from the standard allocation formula. First, the proponent of the
deviation must show that the gross receipts formula does not fairly represent
the taxpayer's in-state business activity. Second, the proponent of change
must demonstrate that its proposal is reasonable, but not that its alternative is
fairer than any other formula. I therefore agree with the majority's
modification of the test used by the Court of Appeals, but disagree with the
majority's application of these principles here.
Since we are holding that the burden of proof is on the Department, I agree
with the Court of Appeals that we should remand this matter to the ALC for
reconsideration. Whether the Department can meet its burdens are questions
of fact which, in my opinion, should not be decided on certiorari despite the
parties' agreement that we do so. The ALC placed the burden of proof on
CarMax West, and accordingly its findings of fact and conclusions of law are
premised on that error of law. It is therefore not surprising that as the
majority states, "the Department relied on CarMax West to refute [the
Department's] use of an alternate formula," or that the Department, lacking
any burden of proof, largely offered evidence of what it did rather than why
it did it.
In light of our clarification of the burden of proof, I would remand to the
ALC with instructions to reconsider this matter and to hold an evidentiary
hearing if requested by either party. I would also permit the parties to
reargue the points of law raised in their petitions of certiorari but not decided
by the Court today.
For the reasons given above, I concur in part, dissent in part, and would
remand for reconsideration.